Uncontrollable inflation within three years

Algemeen Dagblad
Erasmus School of Economics

Thousands of billions of euros have been pumped into the European economy in recent years and the end is not yet in sight. More money and more debt seem to be the new medicine against every economic crisis, even in the traditionally sparse Netherlands. But how long will this hold?

The government as a shock absorbor

Casper de Vries, Professor of Monetary Economics at Erasmus School of Economics, thinks that economical cutbacks are unwise. According to him, too many savings were made after the previous crisis in 2012, which led to a second dip in the economy. In addition, de Vries believes that the crisis today cannot be compared to the credit crisis of ten years ago. Now supply and demand are disappearing. Then a player is needed to absorb and distribute the shocks'. And that should be the government'.

This is exactly what happens. Governments all over the world are doing what they can to dampen the settlement of the corona crisis.  Also in Europe, billions are spent to protect citizens' jobs and purchasing power in the hope that the crisis is temporary and that the measures will be short-lived. The central banks, the ECB in the EU and the Fed in the US, are buying up loans en masse. This money ends up in the hands of governments, who use it to pay for their extra spending. Another part goes to the banks and pension funds. They are supposed to spend the money again, which should provide extra economic growth, but in the end the money mainly goes to large companies that do not need it. In addition, consumers are not helping as drivers of the economy. Instead of spending their money, they are saving for an extra buffer.

Aiming for inflation

The ECB has been aiming for an inflation rate of just under 2% for years. Inflation reduces the value of debt and makes it easier to repay them, which in turn lowers the threshold for taking on debt. However, the 2600 billion that the ECB has pumped into the European economy over the last few years has for a variety of reasons not led to additional price rises and thus to inflation.

Loss of billions

If the economy improves over time, people will start to spend their wealth. All that extra money will increase inflation. The only thing the ECB can then do is raise the interest rates. A higher interest rate means a lower price for a bond, leading to billions of losses for the central bank. Casper de Vries argues that the ECB should start reducing the bond portfolio now, but sees the difficulties faced by the ECB in doing so. For instance, countries would have to start cutting back, but there is no willingness to do so. If the ECB stops stimulating, there is a chance of recession and we have become too afraid of that', says de Vries.

Professor
More information

Read the entire article from het Algemeen Dagblad here, 3 September 2020 (in Dutch).